The minimum wage

Danger zone

It began moderately, but has risen too far, too fast and now threatens jobs

SO FIRMLY entrenched in the political economy has the minimum wage become that its latest increase, on October 1st, to £5.35 ($10.08) an hour, caused little stir. Yet the introduction of a national pay floor in 1999 was one of New Labour's most radical economic policies. Although minimum wage rates had previously covered a few industries, this was the first time that a general rate had been set.

During the 1997 election campaign the Conservatives said that the policy would destroy jobs. Some economists calculated that hundreds of thousands of people might be put out of work. These dire warnings proved way off the mark after the national minimum wage came into force seven years ago. The feared job losses did not materialise.

However, that benign outcome had much to do with the cautious approach the government, advised by the Low Pay Commission, at first adopted. In April 1999 the main rate—for workers aged 22 or over—was set quite low, at £3.60 an hour. Eighteen months later, the rate edged up to £3.70. At this level it was worth only 36% of average hourly earnings for all employees. Furthermore, workers aged 18 to 21 had a separate, lower rate, which began at £3 in 1999 and was raised to £3.20 in October 2000.

The modest starting point for the minimum wage meant that it affected relatively few workers. The commission initially thought that it would raise the pay of around 2m workers but in practice only about a million gained. This limited any possible loss of jobs.

After the initial period of caution, however, the government got bolder. This month's increase pushed the main rate up by 6%, comfortably ahead of average earnings which went up by 4.4% in the past year. Since 1999 the minimum wage has risen by 49%, outstripping average earnings which increased by 32% in the past seven years (see chart). As a result, it is now worth 41% of average hourly earnings.

This trajectory contrasts sharply with what has happened in America. The federal minimum wage has stayed at $5.15 since September 1997. At this level, it is worth 27% of average hourly wages for all employees other than those working in agriculture or for the federal government—far stingier than Britain's rate.

The commission accepts that the period when the minimum wage rose faster than average earnings is over. The worry, however, is that it has already risen to a level that will hurt employment. The Confederation of British Industry said on September 24th that businesses in several parts of the economy, such as retailing, were struggling to cope with the minimum wage. A few days later the British Chambers of Commerce (BCC) added that the latest increase would have “serious implications” for firms. David Kern, who advises the BCC, says: “There is now a distinct risk that the minimum wage will have an adverse effect on jobs.”

Whether employment will necessarily take a big knock is uncertain. Mainstream economic theory suggests that a minimum wage set too high will cost jobs. However, the evidence from other countries has been quite mixed. Some studies find no impact on employment whereas others find the jobs do indeed disappear, especially among young people.

In a recent appraisal of employment policies in the world's developed economies, the OECD said that “a moderate minimum wage generally is not a problem”. Britain's experience in the first few years of the policy bears out that judgment. But more recent increases have pushed the rate up to a level where it may inflict damage.